Last week, a Manhattan appellate panel in Antonini v. Petito, 2012 NY Slip Op 04393 (1st Dept June 7, 2012), reversed a trial court order and granted summary judgment terminating the combined 50% interest of two LLC members based on their alleged failure to contribute to mortgage payments for the LLC’s real property. The court’s ruling enforced a provision in the LLC’s operating agreement that closely tracks the language in §502(c) of the Limited Liability Company Law authorizing, among other consequences for failure to make required capital contributions, the “forfeiture of the defaulting member’s interest.”

The harsh outcome is surprising not least of all because the operating agreement’s provision, while not a model of clarity, raises a question whether the specified array of penalties for failure to make a “required contribution” applies only to a member’s failure to make the initial capital contribution which is expressly qualified “as the sole Capital Contribution to be made by [the member].” The mortgage payments at issue were not the initial contributions and, in fact, there was no dispute that, by the time they arose, the “defaulting” members’ capital contributions exceeded those made by the prevailing 50% member. The outcome is stranger still because the members’ obligation to contribute toward the mortgage payments is contained in a separate litigation settlement agreement that makes no reference to — much less does it purport to amend — the operating agreement’s provision for capital contributions.

Background

The case involves a realty company named Bridgeview at Broadway, LLC (“Bridgeview”) formed in 2006 by three individuals as equal one-third members: Vittorio Antonini, Orazio Petito and Rocco Petito. In September 2006, Bridgeview paid $2.75 million to acquire for renovation and development two adjacent mixed-use properties in Brooklyn’s Williamsburgh section, next door to the famous Peter Luger’s Steakhouse. The purchase was mostly financed with a $2.5 million mortgage loan from BRT Realty Trust. Each member made a required initial capital contribution of $285,000.

The venture quickly experienced problems triggering a dissolution lawsuit by Antonini in 2007 accusing Orazio Petito, who at that time was the sole managing member, of failing to proceed with the development project and Petito accusing Antonini of improperly using Bridgeview’s property for his personal benefit. In April 2009, the parties entered into a 20-page settlement agreement (read here) resolving not only that suit but two others involving two other realty companies.

The Settlement Agreement

Under the settlement, Antonini, whose membership interest in Bridgeview had been diluted to under 31% due to disparate additional capital contributions, increased his stake to 50% in consideration of the Petitos receiving a $50,000 return of capital contributions and Antonini giving promissory notes totaling $330,000 to the Petitos, each of whose membership interest thereupon was reduced to 25%. Repayment of the notes was conditioned upon a subsequent refinancing of the BRT mortgage which, apparently, never happened. The settlement agreement made Antonini and Orazio Petito the co-managing members of Bridgeview.

Section 1 of the settlement agreement set forth a series of “Representations and Warranties” mostly confirming ownership of membership interests in the several LLCs. Tucked into the representations, in Section 1.9, was the following provision concerning capital contributions:

Antonini, Orazio and Rocco represent that after the return of [$50,000 capital contributions to the Petitos], Bridgeview shall have sufficient assets to meet its current obligations; provided, however, that the Bridgeview members shall each be required to make monthly contributions to Bridgeview in order for Bridgeview to keep current with its obligations under the [BRT mortgage loan] and any future loan(s) obtained by Bridgeview to complete the renovations of Bridgeview (“Additional Contribution(s)”).

Significantly, or so it would seem, Section 2.1 of the settlement agreement set forth an extensive series of express amendments to Bridgeview’s operating agreement addressing a variety of management issues, but it did not amend the operating agreement’s provision (quoted below) dealing with the consequences for a member’s failure to make a required capital contribution.

The Temporarily Halted Contributions

For several months afterward, Antonini and the Petitos made equal monthly contributions toward the BRT mortgage payments. From July 2009 through July 2010, however, the Petitos stopped their payments due to a new impasse over the lack of progress with the renovation work. During that period Antonini alone contributed over $220,000. The Petitos resumed monthly payments in August 2010.

Antonini’s Notice of Forfeiture

In October 2010, following a new round of inconclusive litigation, Antonini signed and delivered to the Petitos a document entitled “Notice of Action of Member of Bridgeview at Broadway, LLC Taken Pursuant to Articles IV(5) and V of the Operating Agreement” (read here). The Notice invokes the Petitos’ failure to make contributions from July 2009 through July 2010 as ground to “forfeit their membership interests” in Bridgeview under Article V, §1 of the operating agreement (read here) which provides:

Each member of this Company shall contribute the amount set forth under his name as set forth in the Books and Records of this Company as the sole Capital Contribution to be made by him. Such contribution may be in cash, property or services rendered or a promissory note or other obligation to contribute cash or property or to render services. The failure of a member to make any required contribution shall be subject to any or all of the following consequences at the option of a majority in interest of the remaining members who shall be entitled to vote thereon.

a. Reduction or elimination of the defaulting member’s interest; and/or

b. Subordination of the defaulting member’s interest to that of the non-defaulting members; and/or

c. Forced sale of the defaulting member’s interest; and/or

d. Forfeiture of the defaulting member’s interest; and/or

e. the lending by the other members of the amount necessary to meet the defaulting member’s commitment; and/or

f. Any other reasonable and lawful method to rectify such member’s failure to meet his obligation.

As noted earlier, the listed consequences mimic those specified in LLC Law §502(c)’s non-exhaustive list of actions that may be taken if so authorized in the operating agreement. The only consequence included in the statute not listed in the operating agreement’s provision is for the appraisal and redemption of the offending member’s interest.

Antonini’s Lawsuit to Enforce Forfeiture

One month later, in November 2010, Antonini filed a complaint against the Petitos seeking a judgment declaring enforceable the notice of forfeiture (read here). His complaint alternatively sought to reduce the Petitos’ membership interests on account of the imbalance in contributions since July 2009, and it also asserted several claims for damages.

The Petitos filed an answer in January 2011 (read here) alleging that, virtually from the project’s inception, Antonini consistently obstructed the renovation and financing of the properties, and prevented Bridgeview from generating rental income. The Petitos also asserted several counterclaims against Antonini for damages and to recover on the promissory notes given by him as part of the 2009 settlement agreement.

Concurrently with filing their answer, the Petitos made an additional cash contribution to Bridgeview in the approximate amount of $165,000 which was over half the amount contributed by Antonini in July 2009 through July 2010.

The Lower Court’s Decision Denying Summary Judgment 

In April 2011, Antonini moved before Manhattan Commercial Division Justice Jeffrey K. Oing for summary judgment on his claims to enforce the notice of forfeiture and, alternatively, to dilute the Petitos’ membership interests.

The motion was heard in August 2011, at which time Justice Oing issued an oral decision (read transcript here) denying Antonini’s motion. Justice Oing held that an issue of fact was presented whether the term “any required contribution” in Article V, §1 of the operating agreement was intended to include the monthly mortgage loan “contributions” mentioned in Section 1.9 of the 2009 settlement agreement. Justice Oing also stressed Antonini’s failure to submit any affidavit by the drafter of the operating agreement explaining the meaning of the term “any required contribution” in the operating agreement and, specifically, whether it was intended to apply to contributions other than the initial capital contribution of $285,000 per member.

The Appellate Court’s Reversal

Antonini appealed the denial of his motion to the Appellate Division, First Department, which issued its three-paragraph ruling last week reversing Justice Oing’s order and declaring that Antonini had the right to forfeit the Petitos’ membership interests. The appellate court’s discussion of the central issue in the appeal consists entirely of the following passage:

In this dispute among members of a limited liability company, plaintiff seeks to have defendants declared in breach of the operating agreement based on their failure to make mortgage payments for more than one year on the LLC’s sole asset and to invoke the remedies of either forfeiture or diminution of their interests. In light of the circumstances in which it was executed and the reasonable expectations of the parties, the operating agreement unambiguously entitles plaintiff to invoke these remedies. The language in the agreement tracks the authorizing provision of Limited Liability Company Law § 502(c) as a penalty for defendants’ failure to make “any required contribution” (see Greenfield v Philles Records, 98 NY2d 562, 569-570 [2002]; Goldman Sachs Group, Inc. v Almah LLC, 85 AD3d 424, 426-427 [2011], lv dismissed 18 NY3d 877 [2012]). The penalties under the negotiated agreement would not effect a forfeiture (see generally 1029 Sixth v Riniv Corp., 9 AD3d 142 [2004], appeal dismissed 4 NY3d 795 [2005]).  

The decision does not mention the reference to “sole Capital Contribution” in Article V, §1 of the operating agreement, nor does it mention the fact that the settlement agreement did not amend that provision of the operating agreement. The decision also does not explain how, as the court wrote, “[t]he penalties under the negotiated [operating] agreement would not effect a forfeiture” when the court granted summary judgment on Antonini’s claim to effect a forfeiture.

Bad Agreement/Bad Law

If you take a few minutes to examine the Bridgeview operating agreement you’ll see that it’s a fill-in-the-blank form that makes no apparent effort to tailor the members’ rights and obligations to the particular management and financial circumstances attendant to the venture. You’ll also likely conclude that the form of agreement was severely outdated by the time it was executed in 2006, reflecting none of the critical amendments to the LLC Law that became effective in 1999. For example, Article III, §10 mimics the pre-1999 law permitting a member to withdraw at will from the LLC upon six-month’s notice, which automatically triggers the withdrawing member’s right to be paid fair value for his or her membership interest — a perfectly terrible idea for any LLC but especially for a single-asset realty development company such as Bridgeview, financed with a mortgage loan secured by the members’ other assets.

The penalty provision for failure to make “any required capital contribution” might as well have been entitled, “Guarantee the Members Will End Up in Litigation.” I cannot imagine that anyone who read and understood the provision would willingly agree to risk losing his entire investment based on the whim of one member claiming that another member was short a dollar — that’s all it takes — on his capital contribution.

It’s difficult to understand the appellate court’s expressed reliance on the “circumstances” surrounding the 2009 settlement agreement and the “reasonable expectations of the parties.” The question should be, do the words used in the agreements plainly evidence the parties’ intent, or is there an ambiguity requiring the court to resort to extrinsic evidence? The court concludes that the 2009 agreement “unambiguously entitles plaintiff to invoke” the penalties in the operating agreement, but this conclusion is hard to square with the sparse wording in the 2009 agreement and the ambiguous (at best) reference to “any required contribution” in the operating agreement.

As I see it, the muddled penalty provision — Was it intended to apply to subsequent, additional capital contributions or only to the initial “sole” capital contribution? — and the vague provision in the settlement agreement calling for “contributions” to pay the mortgage loan — Who decides when it’s needed and in what amount or percentage? In the form of a loan or capital contribution (a decision frequently deferred until tax return preparation the following year)? Subject to the penalty provision in the operating agreement or not, in light of the fact that the settlement agreement neither referenced nor amended the penalty provision? — has produced a ruling that is not only a sharp blow to the losing litigants — the Petitos effectively have been forced to gift their entire investment, over $1.2 million, to Antonini — but also sends the wrong signal to those who draft operating agreements, which should not serve as a trap for the unwary. Yes, the LLC Law permits members to adopt draconian sanctions in the operating agreement, including forfeiture of membership interest, for failure to make a required capital contribution. But, at a minimum, such draconian consequences should be spelled out with great clarity and with a heightened burden placed on those seeking to enforce them.

Update December 7, 2019:  Several years after the appellate court’s Antonini ruling, Petito filed a malpractice lawsuit against his own lawyer, alleging essentially that he gave Petito bad advice by recommending that he withhold his contribution as a method of resolving his dispute with Antonini, without advising him of the risk of forfeiture. In March 2018, the lower court dismissed the case but a year later, in Petito v Law Offices of Bart J. Eagle, PLLC, 170 AD3d 555 [1st Dept 2019], the appellate court reversed and reinstated the malpractice claim. The case is still pending.